Course: Risk Management: For this discussion, we will consider the relationship
ID: 1172297 • Letter: C
Question
Course: Risk Management: For this discussion, we will consider the relationship between risk and reward and how it applies to a broader area of risk management. In this module we discussed various quantitative asset management tools employed by investors for determining an expected rate of return (reward). First Post Please address the following questions: In your opinion, what are the ramifications of an investor electing not to use one of these tools? What steps, tools, or guidelines, have you applied in your professional lives to assess the relationship between risk and reward?
Explanation / Answer
An investment process usually involves some three major aspects, one, the resources, two, the investment activity(s) and three, the results or outcome of an investment. This means that the investment activity(s) usually determines the results to be obtained (Bruce J. F., 2003).Investment results are usually the reward or return of that particular investment. One of the major factors that affect the investment outcome is usually the risk involved with that particular investment. This relationship creates the risk-reward/return concept which is generally determined as follows, high-risk investments are usually considered to be of high reward/return while low-risk investments are usually considered to be of low reward/return (Billings et al., 2001).
This concept will, therefore, bring up the aspect of risk management in investment. One of the major steps in risk management is the application of quantitative asset management tools that would identify the risks involved in an investment and therefore determine the expected rate of return (reward) (Crockford and Neil, 1986). These tools usually aim at controlling the risks that would be involved in an investment through minimizing them. Therefore, failure to apply such tools in making investment decisions might lead to the following: application of resources for investment opportunities that are more risky than expected, failure to minimise the risks involved e.g. by not diversifying on the investments, not maximising on returns by having lower expected rates of return and experiencing negative deviations on investment objectives.
From my professional experience, some of the steps or guidelines that have applied in assessing the relationship between risk and reward are the rule of risk-return concept. I usually relate high return investments with high risks thus I have usually involved thorough risk management actions in this scenario. On the low return investments, I have usually associated them with low risks hence I bank on minimum risk management actions. I Have also been applying the use of benchmarks and historical records on certain investments when determining the risk and return components of these investments. In such a scenario, I usually make minimal changes in line with the current trending economic and market conditions to determine the expected return of the investments and the risks involved. The use of modern portfolio theory in diversifying investments have also been a preferred tool and also the capital assets pricing model which explain the relationship between the expected return, non-diversifiable risks and valuation of securities in an investment decision-making process.